Abstract
We examine four variations of a model in which oligopolistic retailers compete in a downstream market and one of them is a large retailer that has its own exclusive supplier. We demonstrate that an increase in the buyer power of the large retailer vis-à-vis its supplier leads to a fall in the retail price and an improvement in consumer welfare. More interestingly, we find that the beneficial effects of an increase in buyer power are large when the intensity of downstream competition is low, with the effects being the largest in the case of downstream monopoly.
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Notes
Specifically, Chen (2003) shows that as the dominant retailer gains more buyer power, the retail price will decrease but the welfare effects will depend on the market share of the dominant retailer and the difference in the costs between the dominant retailer and the other retailers. When the number of fringe retailers is sufficiently large, increased buyer power will improve social welfare.
These assumptions on the second- and third-order derivatives of \(P(Q)\) ensure that the second-order condition of each firm’s profit-maximization problem is satisfied and that the pass-through rate of a higher wholesale price is smaller when the downstream market becomes more competitive. The role of the pass-through rate is discussed in Sect. 3.2 after Eq. (17).
Hence, we assume that all retailers have the same retailing costs. For an analysis on how a difference in retailing costs affects the distribution of profits among retailers and suppliers, see Dukes et al. (2006).
Indeed, early examples of retailer power given by Galbraith (1952) were the major chain stores in the first half of the twentieth century, such as A&P and Sears, Roebuck. In these examples, it was their large sizes that stemmed from selling in many local markets that conferred on these retailers the power to obtain lower prices from their suppliers.
However, it is beyond the scope of this paper to demonstrate that these assumptions hold for every possible mechanism of buyer power.
The proofs of all propositions and corollaries are relegated to the “Appendix”.
Here retailer R 1 is able to purchase a larger quantity from its supplier despite the lower wholesale price because the price is still above the supplier’s (constant) marginal cost of production.
This can be seen from the scant attention that was paid to buyer power in past merger-enforcement guidelines in Canada, the E.U., and the U.S. Over time, however, competition authorities are becoming more cognizant of potential buyer-power issues in merger reviews. For example, in 2014 the U.S. Department of Justice (DOJ) objected to the acquisition of Hillshire Brands by Tyson Foods on the ground that the transaction would likely reduce competition for purchases of sows from farmers (US Department of Justice 2014). The merger was approved after Tyson Foods agreed to divest its sow-buying business that competed directly against Hillshire’s sow slaughter business. Further, buyer power considerations were central to the DOJ’s concerns in its evaluation of the Comcast-NBCU merger and the proposed Comcast-Time Warner Cable merger. See Rogerson (2013) for a detailed discussion of these concerns in the Comcast-NBCU merger case.
In principle, inside options and outside options are concepts in non-cooperative bargaining theory. However, as explained in Muthoo (1999), the inside option point corresponds to the disagreement point, and the outside option point constrains the set of possible agreements in the Nash bargaining problem. The latter result is known as the Outside Option Principle. That is why the inside options enter the Nash product while the outside options are included as constraints in (9) below.
In the literature, a number of authors have examined the sources of buyer power. They include Katz (1987), Chipty and Snyder (1999), Montez (2007), Inderst and Wey (2007, 2011), Inderst and Valletti (2011), and Chen (2014). Among them, Montez (2007) poses the question, “Why bake a larger pie when getting a smaller slice?”
For example, the consolidation in European retail markets involved a significant number of cross-border mergers (Inderst and Wey 2007, p. 45). In particular, Wal-Mart entered several EU countries via a string of acquisitions, including that of Asda (UK) and Wertkauf (Germany).
In 1999, for example, Canada’s Competition Bureau approved two mergers of grocery retail chains after the merging parties agreed to divest certain stores in those local markets where they had significant overlaps. In each case, the two retail chains operated primarily in separate parts of the country and they overlapped in only a small number of local markets before the merger (Competition Bureau 1999a, b). In the U.K., the Competition Commission approved the acquisition of Safeway by Wm Morrison Supermarkets conditional on the divestiture of over 50 stores to address adverse competition effects of the merger in various local retail markets (Competition Commission 2003).
The fixed fee could take the form of a slotting allowance, which is a lump sum payment made by the supplier to the retailer. Indeed, if we incorporate a two-part tariff into the price competition model in IV.2, we can show that such a payment would arise if the retailer’s buyer power is sufficiently strong. Details are available upon request.
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Acknowledgments
For comments we thank Gamal Atallah, Rose Anne Devlin, Can Erutku, Patrick Rey, Anindya Sen, Roger Ware, Larry White, the participants at the 2012 EARIE conference, and two anonymous referees. Financial assistance from the Social Sciences and Humanities Research Council of Canada is gratefully acknowledged.
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Appendix: Proofs of Propositions and Corollaries
Appendix: Proofs of Propositions and Corollaries
Proof of Proposition 1
The first statement of this proposition follows from (7). Consumer welfare is measured by consumer surplus, given by
By Assumption I and Eq. (5), we find that
Social welfare is measured by total surplus, which can be written as
Differentiating (33) and use the retailers’ optimization conditions, we obtain
The sign of (34) is determined by (5), \(\partial q_{1} /\partial w < 0\), \(\partial q_{I} /\partial w > 0\), Assumptions I and III, and \(q_{1} \ge q_{I}\) (because \(w \le c\)). □
Proof of Proposition 2
The first statement of this proposition follows from Assumption II, (5), (6), and (8). Differentiating (31) with respect to \(n\), we obtain:
the sign of which is determined by (5), (6), and Assumption II. Differentiating (33), we find:
The signs of the first two terms on the RHS of (36) are positive, while the sign of the third term is indeterminate. However, the third term vanishes if \(c = c_{s}\) (in which case \(w = c_{s}\) by Assumption III). By continuity, \(\partial TS/\partial n > 0\) if \(c - c_{s}\) is sufficiently small. □
Proof of Proposition 3
From (5), we derive:
Differentiating (37) with respect to \(w\) and \(n\) (respectively), we find
Now differentiate (7) to obtain:
The sign of the first term on the RHS of (40) is positive by (38), (39) and Assumptions I and II. The sign of the second term is positive as well if \(\partial^{2} W/\partial n\partial \gamma > 0\). Hence the sign of (40) is positive under the same condition. □
Proof of Corollary 1
Follows from (16) and Proposition 3. □
Proof of Corollary 2
Using the linear demand function, we write the total surplus as:
Differentiate (41) to obtain:
which is positive if \(p - 2c + c_{s} > 0\). Using (11), we can show that the latter holds for all \(\gamma \in (0,\,1)\) if \(c - c_{s} < (a - c)/(n + 2)\). □
Proof of Proposition 4
To simplify presentation, define \(Z \equiv (2 - \theta )[2 + (n - 1)\theta ]\). Using (19), (20) and (23), we find:
From (23), we obtain:
□
Proof of Proposition 5
Define
It is easy to verify that \(T > 0\) and that \(Y/T > c\). Then the wholesale price in (29) can be written as \(W^{B} (\gamma ,n) = (1 - \gamma )Y/T + \gamma \,c_{s}\). Since \(Y/T > c\) and \(c > c_{s}\), we conclude that \(W^{B} (\gamma ,n) > c_{s}\) for \(\gamma \in (0,\;1)\). The threshold \(\gamma_{L}^{B}\) is obtained by solving \((1 - \gamma )Y/T + \gamma c_{s} = c\), which yields:
Differentiating (29), we find:
From (50), we obtain
where \(G \equiv [\theta^{2} (2n^{2} - 6n + 5) + \theta (4n - 7) + 2]a - [\theta^{2} (2n^{2} - 6n + 5) + \theta (2n - 3)]c,\) which is positive because \(a > c\).
Define \(S \equiv 2[1 + \theta (n - 2)][2 + \theta (n - 2)] - \theta^{2} (n - 1)\). Differentiating (26), we obtain
which is clearly positive if \(\theta^{2} (n - 2)n + 3\theta - 2 \ge 0\). In the case where \(\theta^{2} (n - 2)n + 3\theta - 2 < 0\), we can show that \((1 - \theta )[\theta^{2} (n - 2)^{2} + 3\theta (n - 2) + 2] > - \theta [\theta^{2} (n - 2)n + 3\theta - 2]\). Moreover, it can be verified that \(G > (Y - Tc_{s} )\) and \(S > T\). These imply that (53) is positive in this case as well.
Regarding the price of the retailers other than R 1, we obtain from their best response functions at stage 2
Differentiating (54) and using (52)–(53), we can verify that \(\partial p_{I}^{B} /\partial \gamma < 0\) and \(\partial^{2} p_{I}^{B} /\partial n\partial \gamma > 0\). □
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Chen, Z., Ding, H. & Liu, Z. Downstream Competition and the Effects of Buyer Power. Rev Ind Organ 49, 1–23 (2016). https://doi.org/10.1007/s11151-016-9501-8
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DOI: https://doi.org/10.1007/s11151-016-9501-8